Problem 6-31 Financial Break-Even Analysis Another utilization of cash flow anal

Question

Problem 6-31 Financial Break-Even Analysis

Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 156,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $1,960,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimate that in five years this equipment can be salvaged for $166,000. Your fixed production costs will be $281,000 per year, and your variable production costs should be $10.10 per carton. You also need an initial investment in net working capital of $146,000. The tax rate is 35 percent and you require a 10 percent return on your investment. Assume that the price per carton is $17.60.

Calculate the project NPV. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

What is the minimum number of cartons per year that can be supplied and still break even? (Do not round intermediate calculations and round your answer to the nearest whole number. (e.g., 32))

What is the highest fixed costs that could be incurred and still break even? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 156,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $1,960,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimate that in five years this equipment can be salvaged for $166,000. Your fixed production costs will be $281,000 per year, and your variable production costs should be $10.10 per carton. You also need an initial investment in net working capital of $146,000. The tax rate is 35 percent and you require a 10 percent return on your investment. Assume that the price per carton is $17.60.

Explanation / Answer

Ans 1 Year 0 1 2 3 4 5 Discount factor @10%                         0.909            0.826            0.751            0.683            0.621 Machine Investment                   (1,960,000) Working Capital reqd                      (146,000) Depreciation                     392,000       392,000       392,000       392,000       392,000 Post Tax benefit of Depreciation@65%                     254,800       254,800       254,800       254,800       254,800 PV of Depreciation benefit                         965,856                     231,636       210,579       191,435       174,044       158,163 PV of Salvage value of Machine                         103,042       166,000 PV of Total Cash Flow to be earned for Break even                     1,037,102 Total contribution $7.50 per pc for 156,000 pcs                 1,170,000    1,170,000    1,170,000    1,170,000    1,170,000 Fixed costs                  (281,000)     (281,000)     (281,000)     (281,000)     (281,000) Net Income                     889,000       889,000       889,000       889,000       889,000 Post Tax Net Income                     577,850       577,850       577,850       577,850       577,850 PV of Post Tax net Income                     2,190,424                     525,318       477,562       434,147       394,706       358,690 NPV                     2,190,424 Therefore NPV is $ 2190424 Ans 2 PV of Total net income required to recover Fixed costs                     1,037,102 Year 0 1 2 3 4 5 Total contribution $7.50 per pc for 93625 pcs per year                     702,187       702,187       702,187       702,187       702,187 Fixed costs                  (281,000)     (281,000)     (281,000)     (281,000)     (281,000) Net Income                     421,187       421,187       421,187       421,187       421,187 Post Tax Net Income                     273,772       273,772       273,772       273,772       273,772 PV of Post Tax net Income                     1,037,771                     248,883       226,257       205,689       187,002       169,939 Therefore yearly 93625 pcs required to be supplied per year to break even Ans #.3 Year 0 1 2 3 4 5 Total contribution $7.50 per pc for 156,000 pcs                 1,170,000    1,170,000    1,170,000    1,170,000    1,170,000 Fixed costs                  (749,000)     (749,000)     (749,000)     (749,000)     (749,000) Net Income                     421,000       421,000       421,000       421,000       421,000 Post Tax Net Income                     273,650       273,650       273,650       273,650       273,650 PV of Post Tax net Income                     1,037,310                     248,773       226,157       205,597       186,919       169,863 So , at Fixed cost level of 749000 per year , it is still possible to break even

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.